John Kelly
Talks exclusively about gala's unprecedented tertiary buyout.
In his first in-depth interview since leading an unprecedented tertiary private equity buyout of Nottingham leisure group Gala, chief executive John Kelly reveals to Jim Pendrill just how close he came to flotation.
John Kelly is not a gambling man. Then again, as boss of a British gaming company he isn't allowed a flutter on these shores anyway.
That doesn't stop the 55-year-old jetting off to Las Vegas every now and again to play the tables, but one must stress that during our meeting over a gaming table at Gala's plush Nottingham casino - a stone's throw from the company's head office - not a card was turned nor a roulette wheel spun in anger.
Given the way Kelly's luck has run since leading a management buy-in at Gala barely five years ago (and since leading two further buyouts) I feel as though I should be joining him for those Vegas trips.
However, to put it all down to luck would be unfair on the man. Sure, you need luck in driving any business forward, but you also need acute judgement, business acumen and innate skill in daring to tread where others fear to do so - Kelly has certainly done plenty of that.
Take the history of the 1997 buy-in. On the face of it the backdrop could hardly have been more uninspiring for the bingo industry. At the time the National Lottery was eating into profits at bingo clubs and the whole sector appeared dead on its feet. Kelly, a former MD of Mecca's bingo division before its sale to Rank, was running a bingo business with 35 clubs in the West Midlands, a business which he says was going nowhere. So much so that he recommended to the banks that controlled the clubs to sell up in return for backing him with a buy-in team to look at acquiring other assets in the leisure arena.
Talks began with a number of VCs and yet Kelly soon found himself returning to the bingo business.
"While we looked at a number of options I knew the bingo business extremely well and to me there was real evidence if you took a long hard look at the sector that it had reached the bottom of the curve and was moving into recovery." He adds with a wry smile: "That of course meant it was the best time to buy."
Which meant persuading someone to sell. Kelly's radar found itself repeatedly coming back to Midlands corporate giant Bass, a company which at the time was very much focused on its bars and hotels (which has now split) and whose bingo club business was falling short of targets.
Kelly, no doubt helped by his track record in the sector and his unbridled passion for the industry (he admits to being "absolutely absorbed" by leisure from a young age, coming as he did from an Edinburgh family which owned a chain of Scottish cinemas), eventually encouraged Bass to sell and put the business out to auction. Backed by his bankers and VCs PPMV (the private equity arm of Prudential) and Royal Bank Development Capital, Kelly raised the cash he needed and did the deal for £3240m.
Looking at what the business is worth today - a cool £31.24bn - the price paid then seems a snip. But market sentiment is everything. Then the sector was unloved, unsexy and untrendy. Today you cannot keep the punters away from the door.
I recall reading that bingo is today played by one in 10 of all women and one in 10 of all people over 75.
Kelly, expressively leaning his well-built 6ft-plus frame over the gaming table, immediately shoots me down for over-simplifying the picture.
"The truth is that three and a half million adults regularly play bingo, that is three or four times a year minimum. And the average age? Let me tell you, 47. Yes, 47. Furthermore nearly half of all new members are aged between 18 and 35. Don't tell me that bingo is only played by elderly women!
"That said, bingo is a woman's game and we market it as such. It's the game's unique selling point. You won't find cheap beer in any of our clubs."
The rise in the game's popularity also has much to do with the rise in general standards of clubs which are now safe, clean and welcoming environments for a night out. We are sitting in a Gala casino (one of the casinos acquired by Gala following its £3235m purchase of Ladbrokes' casinos from Hilton in 2000) where you could eat your lunch off the carpet, I have no reason to doubt that the same impeccable standards are applied elsewhere in the group.
Kelly says: "When we take bankers or financiers out to clubs in London they cannot believe the quality of the facilities. The old images of bingo halls are completely defunct."
All of which means that bingo and casinos are big business and - as far as Kelly is concerned - licences to print money. Gala is now Britain's biggest bingo club owner with a 40 per cent share of the market, 166 clubs and 6m members. Throw in its 28 casinos and you have another 1.2m punters.
Kelly proudly states: "We have a business that throws off cash and is highly cash generative. Our EBITDA [earnings before interest, tax, depreciation and amortisation] was £3115m last year."
No wonder the private equity players have become so fascinated with the company. Gala's tertiary buyout earlier this year in which Candover and Cinven ploughed £3274m each into the business (with debt provided by CSFB and Merrill Lynch) as it bought out CSFB Private Equity and PPM Ventures, set several records. Not only was it according to popular opinion the first ever tertiary buyout - where the ownership of a company among private equity players has changed hands three times - but the three deals were completed in barely five years, an astonishing timeframe that will struggle to be ever beaten for a company of Gala's size.
The latest deal, which received final European Commission backing last month, was also regarded as something of a milestone for private equity, confirming in the eyes of many that VCs have become the new conglomerates and one of the most important sources of funding for middle-market businesses.
"VCs get an extremely bad press which they don't deserve," asserts Kelly. "They are just another source of capital. For me it is simple. You either get capital from the debt market, the public market or VCs. The VCs I have worked with have all been enormously supportive when we have delivered.
"Regarding the latest deal, take my relationship with Candover. I have known them for five years and they have been tracking the business. They know the leisure market and are professional investors in those businesses. They also have a track record of not just investing in businesses but developing them too. That is fantastic."
But Kelly knows he cannot take his eye off the ball for a moment, not least as the latest deal burdens Gala with nearly £3700m of debt.
"We have now had three highly leveraged buyouts and have releveraged the business each time. We are now leveraged up to six times our EBITDA which is a big leverage and we could theoretically leverage the business even more. It is a great way of funding the business provided that within the economic model there is sufficient headroom capacity.
"But we would never do a deal that overstretched the business in terms of our leverage. In fact we have never, ever failed a covenant and we have never been anywhere near failing a covenant. We take an enormous amount of time doing our due diligence."
Paying off the interest eats heavily into Gala's profits. Its latest figures for the 12 months to September 2002 show that although the company made almost £3100m operating profit, it paid back more than £370m in interest. The year before, Gala's £372m operating profit was entirely cancelled out by interest payable and the group only made a fractional pre-tax profit thanks to a small profit on the disposal of some fixed assets and through bank interest receivable.
For Kelly though this goes to the heart of the Gala business plan. "For us this company is all about accruing shareholder value and cash generation, it is not about making excess profits. Since 1997 I have now delivered £3600m in terms of shareholder value."
The high debt has also allowed Kelly to proceed with an aggressive acquisition strategy. Less than 12 months after the initial buy-in he bought Ritz Bingo Clubs for £336m, and followed that a year later with the purchase of the Midlands bingo group Jarglen for £321m. In 2000, following the secondary buyout to CSFB Private Equity for £3400m, things really hotted up with the Ladbrokes deal and the £390m acquisition of Riva Bingo (which meant Gala overtook Mecca as the UK's biggest bingo operator).
Since then Kelly has been decidedly quieter on the buying front, preferring instead to bed down the acquisitions, most especially the crucial Ladbrokes casino empire which helps position Gala at the front of the queue as and when gaming laws are relaxed.
"The Ladbrokes deal was enormously important to us. It has taken a lot of work to incorporate it fully into the business."
Kelly doesn't rule out further spending at home or abroad, and admits to having looked on the continent in recent months where Gala has as yet no presence (although Kelly himself does have a French farmhouse).
But he's in no rush. "We are always looking but I'm not desperate for acquisitions. This latest buyout is not about a headlong rush into more M&A. If however an acquisition possibility comes along I know we have the backing of institutions to make them happen.
"I have had several acquisition opportunities in Europe and I have looked at them. But so far I have been very, very underwhelmed by overseas opportunities. For the time being there is too much to do in the UK but gaming is becoming a global business and Gala will one day become a global brand."
The company's debt structure has also allowed for major investment in the business. Since the first buyout more than £3150m has been invested in bingo halls and casinos, all helping to get more punters through the door and more cash on the balance sheet.
So, anyone perplexed by the interest of VC players in the business should be perplexed no further. Kelly says: "Fundamentally this is a wonderful company. At a time when telecoms and internet-based businesses are operating in a tremendously tough environment, we are operating in a robust and defensive sector and have a business which is highly cash-generative. The intrinsic characteristics of Gala are very, very, very solid and as such it has been a remarkably well invested-in business in recent years."
Not without a hint of irony, Kelly adds: "The City has always liked the company too. We have always delivered our budgets and that has made refinancing significantly easier."
I say irony because never mind the City liking the company, will the company ever like the City?
Gala's on-off flirtation with a flotation was one of the most documented "will they, won't they" corporate sagas of last year, particularly after William Hill successfully got away.
Kelly admits that the company came very close indeed to a float. "We got right to the wire with an IPO. In the end the markets were not sufficiently attractive in terms of value while we also had some aggressive private equity buyers.
"This business could be an IPO dream, but in these markets I asked myself did I need an IPO. The answer was no. William Hill has done well in a bleak market environment. We ourselves were not confident about delivering our expectations in the present public markets which are dead."
Kelly insists he takes a pragmatic view of the subject. "I have very broad views about a flotation. My job is to deliver extra options to institutional investors. They should be as wide as possible to give them the opportunity to get returns.
"I think Candover and Cinven paid a fair price and I don't think they overpaid. There is a huge amount of value to come."
Much of that value will undoubtedly come from a relaxation in the UK's gaming laws (see sidebar) although Kelly goes out of his way to stress that he would be foolish to base future growth at Gala solely on any upside from deregulation.
"I regularly talk to ministers and civil servants at the Department of Culture, Media and Sport and there is no doubt that minister Richard Caborn is very committed to deregulation. The Budd report is out in the open and has now been absorbed and widely consulted upon.
"Clearly the existing legislation is creaking and needs reforming but there are dozens of caveats, not least of which is I cannot forecast the legislative timetable. At present all the evidence suggests the reforms will go to the Queens Speech later this year and finally hit the statute book in 2005. But at this stage we still don't know the final make-up of that legislation. As a business we have to forget what is on the horizon. We would never have sold to private equity players if it was only based on the upside from deregulation. They would never have paid the multiples. They paid on the basis of inherent organic growth prospects."
Kelly has also gone on the record to downplay the prospects for a casino-led transformation of Britain's seaside towns, most notably Blackpool whose bid to become the Las Vegas of the north he once dismissed as "publicity fluff", saying the town needed billions of pounds of investment first.
"Oh yes, I got into a lot of trouble for that one," he smirks, then refusing to update me on his thoughts on the subject.
Kelly has also been at the forefront of the debate over the downsides of gambling and the fears that deregulation could lead to a blurring of lines between the different types of gambling that will turn us into a nation of compulsive gamblers.
"However small the social issues there is a social impact and we have to be extremely aware of it. It would be foolish of me to be in denial about it as there are potential issues with deregulation. We already train our staff to spot where there are social issues and the industry has to police itself. We will be even more acutely aware of the issues as and when deregulation comes."
And Kelly certainly intends to be around for it too. Despite his years he has absolutely no intention of cashing in his chips yet. "I have never had so much fun as I have had in the past five years and there is still a lot for me to do with Gala. I will go only when I can no longer make a contribution and hopefully I will know when I am past my sell-by date.
"For the present I have plenty to do in terms of cementing our new ownership. I now need to get on and fully focus on solely managing the business rather than worrying about its ownership. I do not want to be disturbed by more corporate activity. We have a big job to do. I have always been an operator, I love managing."
Kelly likes to run the company along entrepreneurial lines without too many layers of management. Does he not though find himself interfering a little too much in day-to-day operations?
"This business will never become a bureaucratic corporation where there are layers of management you cannot get through and where corporate activity dominates. I always worry whether we have too many
layers of management. At the end of the day this is a business about businesses.
"I personally find I still have to engage with the business otherwise I would get enormously frustrated. I hope I don't meddle too much."
It's a philosophy that has stayed with Kelly ever since he ran his first company, a smart card business, back in the 1980s after leaving Mecca following its purchase by Rank.
"It was a sea-change in my life. I had always wanted to do something where I had great personal influence on the business I was involved in. When you work in large corporates you do not as a senior executive get to really touch the side of the walls and understand how the business works. If I had one piece of advice to any aspiring businessman or woman it would be to take time out working in a small company, getting stuck in at the sharp end. You have to do everything from negotiating with the banks and shareholders to making sure supplies arrive on time."
But for Kelly the days of working in a small company are long gone. "It has been a fantastic run. To move from running a £3250m business to a £31.2bn one has been great fun and it has been a tremendous road for everyone involved. I always knew that Gala had the ability to deliver although I am I suppose somewhat surprised by the dramatic speed by which we have done it."
Easy as one, two, three...
First time around
The date is December 1997 and Kelly leads a management buy-in, acquiring Bass's bingo business with the backing of PPMV, the private equity arm of Prudential, and Royal Bank Development Capital for £3240m.
Second wind
It's March 2000 and at the height of the dotcom boom Gala is sold to CSFB Private Equity for £3400m with the two former owners investing new money too.
A full house
Fast forward to February 2003 and private equity houses Candover and Cinven beat off rivals BC Partners, Permira and Kohlberg Kravis Roberts in an open auction after plans for a flotations are scrapped. Candover and Cinven each invest £3274m for equal equity stakes with CSFB and Merrill Lynch providing debt financing for the rest of the £31.24bn deal. The new owners pay just short of 10 times Gala's expected earnings before interest, tax, depreciation and amortisation for 2003 of £3133m. They say they plan to float the business in "four to five years time".
Budd's reforms have yet to flower
Bingo tax has been abolished but the government has yet to reveal the shape of further deregulation
Britain's arcane gambling laws hark back to 1968 and were originally designed to allay fears over gangster involvement in the industry.
Times have moved on somewhat since and there is overwhelming consensus that our legislation needs bringing into the 21century.
But the precise make-up of those changes is still to be fully finalised before it hits the statute book, and visions of Las-Vegas style resorts across the country are still a long way off.
A report two years ago from former Treasury adviser Sir Alan Budd proposed a wide-ranging relaxation of gaming laws, especially in relation to casinos.
His report included measures such as: allowing more than one form of gambling under one roof; allowing operators to offer live entertainment and alcohol on betting floors; abolishing members-only clubs; removing limits on the size of bingo stakes; and allowing casinos to advertise.
A Gambling Commission is expected to oversee the industry and analysts reckon the changes could provide a 50 per cent boost to Britain's £342bn gambling industry.
But critics argue that the changes will increase the number of gambling addicts and have serious social consequences. In particular they argue that if people are able to go and play bingo and there is a roulette table there too, they will try both.
Meanwhile, in line with other sports betting changes, Gordon Brown as expected abolished bingo tax in last month's Budget and replaced it with a 15 per cent tax on the profits of bingo operators like Gala. However, bingo operators will still have to pay 17.5 per cent VAT on their revenues, unlike bookmakers and pools operators.
For the fuller picture,
subscribe to Insider
every month.
Close
